Well, thank you all for joining us here on day three of the Morgan Stanley Global Healthcare Conference. I am Steve Beuchaw from Morgan Stanley and it’s my pleasure to welcome Accuray and CEO Josh Levine, just coming up on his one-year anniversary with the company.

Before we get into the discussion, I do want to remind you all that all the pertinent disclosures for this discussion are available at morganstanley.com. And before I get into the Q&A, I want to open it to Josh for a couple of opening comments.

Josh Levine

Steve, thank you. As Steve mentioned, this is almost a year anniversary for me. I joined the organization last October. We are a company in a great transition and have been really since fairly early on after I arrived last October. We are a company that traditionally has had a very strong orientation around technology, around R&D and engineering development. I think as you look at our industry overall, we’ve been a product innovator as it relates to technology and to this day, with the new products we’ve launched really have some unique capabilities in terms of product portfolio and technologies relative to the market and competitors.

We probably from a historical perspective [weren’t] as focused on some of the – I would describe them as blocking and tackling fundamentals, just the basic commercial capabilities that accompany and this is like our needs to be able to grow the business longer term and sustain growth over time. And our story really transformation wise is one of a renewed commercial focus, improved commercial execution and keep doing the things quite frankly that it takes to enable good commercial strategies and drive growth in the business through new order growth and having the financial discipline going forward, to build and create a model and drive the model to a sustainable level of profitability which has been another challenge for the company over – from a historical perspective.

We made very significant changes in the cost structure of the organization. In January of this year, we took roughly $10 million a quarter out of OpEx. The bulk of that came from G&A and R&D, and we have really put a lot more emphasis from an investment and a reallocation, if you will, of investment into sales and strategic marketing. So we are lining up the dollars quite frankly where our opportunities and where our biggest needs are quite frankly. So too early to declare victory but we’ve started to drive and see the progress in terms of some of the things that we’ve been doing over the course of the last nine or 10 months.

So with that, I’ll turn it back to Steve.

Steve Beuchaw - Morgan Stanley

I want to address one issue that might be on the minds of a few people in the room or at the conference just because of a very recent transition in the CFO’s office. We’ve known Derek for a while. Derek made a decision to do something different. Can you give us a sense for why it was the right time for a transition and what you were looking for in your new CFO?

Josh Levine

Yes, it’s a great question. Derek realized when I arrived that there were going to be a significant number of changes to the organization to the way we were going about doing business. And Derek had, I think, about two previous public company CFO assignments prior to coming to Accuray. He had done remarkably good thing to make contributions in the previous five years at Accuray prior to my arrival. But he was looking quite frankly – it came to be relatively early on in this transition with my arrival and said, I’d like to see if we could engineer a way to get to a place where I could make an exit and have a chance to do some other things with my life. And quite frankly, I was supportive of that. We didn’t have the ability timing wise, when you look at the magnitude of the changes and the number of things we were doing when I first landed, it was not possible to at least on a short-term basis accommodate Derek’s wishes from a timing perspective.

By the time we got through, when you look at the major restructuring in January, the second convert and putting more money on the balance sheet that we did in February, all of the other things that were taking place, by the time we got to the place timing wise where it made sense to talk to Derek about that and we were already into the year-end close process or close to the year-end close process, as our year ended at the end of June, and so at that point to introduce a new CFO in the middle of that process when you think about year-end close, all of the SEC filings, did not make sense. I didn’t want to disrupt those processes. And it made sense to look at on the other side of the year-end fiscal report. But I’ve had visibility quite frankly to the fact that he was – Derek’s wishes to move on for an extended period of time and so we got a chance quite frankly to look at the available marketplace and candidates. And I'm very excited that we’ve got Greg Lichtwardt on board.

Greg -- I was looking for quite frankly somebody who had public company CFO experience, primarily or preferably in a small-cap, mid-cap environment, preferably if possible at med-tech, med device. When you look at Greg’s background, he fit another really strong piece in my mind of requirement, which was trying to find somebody that was – had understanding and experience with a commercial turnaround or reinvigoration, if you will, of the commercial aspect of the business. Someone that could be a good strategic financial partner to chief commercial officer, operational people internally, someone that would be an effective emissary and envoy from an investor relations and a public market standpoint, and we ran the search for extended period of time and Greg really completely unambiguous, there was no question that he was the right choice, when you look at the requirements that we have laid out. So he’s got most recently the transactional experience at Conceptus which resulted in an acquisition by Bayer, the big German pharm company, and when you look at what they did, I know the CEO that he was working for there, Keith Grossman and they basically had a business that had been moving sideways from a commercial perspective or growth standpoint, their growth had stalled. And over the last few years, they have done a great job of getting that moving in the right direction, ultimately culminating in the transaction with Bayer. So again on all of the fronts and requirements that I had and our board had, we think Greg is a great fit.

Steve Beuchaw - Morgan Stanley

So let’s get to the [build] for the opportunity for the company, let’s say, over the next two years or so. I want to try to break it down into pieces. First, let’s talk about what you're doing commercially, it’s different relative to what the company was doing before. In hypothetical where company hadn’t launched new systems, all technologies from the Accuray that we knew previously, if all you did was change the commercial approach to what you're doing now relative to what the company was doing 12 or 18 months ago, how much bigger could the company have been?

Josh Levine

I think commercial execution would have had an impact of a positive impact on growth. I think that ultimately that growth would've been impeded in terms of the scalability of the opportunity, probably would've been impeded by the fact that we ultimately landed at a place both in the CyberKnife business and ultimately with what we inherited from TomoTherapy prior to the new generation product launch, a place where we really had two specialty products, two niche products. So while the commercial execution, improving commercial execution and really driving a different level of performance management discipline on the commercial side, while it would've been – it would've made a difference, Steve, I don’t know from an upside standpoint, I don’t know that it would've been enough. So I think that when you start to think about catalysts, it’s a combination of very, very important new products, products that from a feature set and functionality standpoint give us a very different market opportunity going forward. We have product certainly on the TomoTherapy side that transitions from specialty device – a device that was very well known and highly regarded for complex cases, very difficult case requiring very, very strong levels of dose controlling capability and that dosing precision, but was probably not from a functionality standpoint going to be a product that would allow you to take on a broad, broad case mix because of treatment speed, treatment planning encumbrances, things that were fundamental, you have to have them as part of your product capability. And so we do move into a very different place on the Tomo side with the new product and the new functionality. It is a mainstream capable product at this point.

Steve Beuchaw - Morgan Stanley

How do you quantify that? The Tomo system is more reliable now, it’s faster, it’s easy to use. You have the fastest planning software on the market. What does the addressable market for Tomo look like today relative to 12 months ago?

Josh Levine

So if you look at where Tomo 12 months ago where there was a previous generation device, what we were playing for in terms of market opportunity, the primary focus really was academic teaching institutions, three-vault customer locations or greater. That was where their primary market had been. For reasons that I just described, at fewer single vault location or even a dual vault location, you couldn't take one of your vaults or your only vault and turn it over to the TomoTherapy Hi-Art generation product. And so if you just conservatively said what does the new device do in terms of opportunity that didn’t exist before, you basically have probably 800 new dual-vault locations that are available to us that we couldn’t participate in before. And if you believe that at certain point that in single vault setting at some point, you get to a place where you can complete in that arena as well. You probably add another 500 or so customer locations.

So you’re dealing with a quantum leap from where we have been. The installed base or the number of three plus vault settings is probably 350-400 maximum kind of number. So you talk about orders of magnitude in terms of the opportunity step-up.

Steve Beuchaw - Morgan Stanley

In centers where you have Tomo functioning today, can you give us a sense of the feedback that you're hearing on this point specifically? Are you seeing evidence in practice that the new Tomo system is enabling the center to use the Tomo in a bigger role?

Josh Levine

Yes, so application across broad case mix, absolutely is part of the feedback we are getting. If you think about IMRT as a percentage of the overall case mix that gets done, IMRT is a very big piece overall. the things that kept us, that limiting factors on the previous generation device were treatment speed, the treatment planning requirements and the lack of user-friendly as quite frankly around the treatment planning capability of the product. And the other thing which we’ve worked very, very hard at over the last two years and done remarkable things to improve was quite frankly a reasonably well-deserved concern about product reliability in the marketplace that we inherited from Tomo when we acquired the company.

And over the last two years quite frankly, we have fundamentally done a 180 on that concern. And if you look at our financials over the last eight quarters, you will see that we have tripled the gross profit in the service revenue stream. It is a – now on a blended basis we’re generating a blended margin in terms of all service revenue of about 29% or 30%. But the primary driver of that improvement over the last eight quarters has been the reliability improvements in the Tomo line, component swap-out in the installed base that was critical, which has driven lower direct labor costs, lower replacement parts costs and we think over time there is more opportunity there for a margin expansion. We think that there is no reason over time like the Tomo product wouldn’t have the same service component of that, wouldn’t have the same profitability levels that the CyberKnife piece does, it runs at about a 40% margin.

Steve Beuchaw - Morgan Stanley

So we’re now at the half-way point of our session. With that, I want to open it up to the audience for any question.

Question-and-Answer Session

Steve Beuchaw - Morgan Stanley

So let’s transition that over to the CyberKnife. When I talk about the opportunity, when I talk about feedback [there as well it’s been], we feel a little bit longer. But first, I want to talk about a hotspot issue I suppose. The MLC – I don’t want to put my bias out there. Can you give us your sense of why it was the right decision not to launch the MLC, or let’s call as the product iteration of the MLC that you had, and how you see the process moving forward to getting to a production version that you do want to launch?

Josh Levine

So a little bit of background on this real quick. The MLC is a component that allows us to – essentially allows the customer to essentially treat a larger patient universe in their setting because of the field size that most of the collimator allows for in terms of treatment area. So just fundamentally you’re dealing with a capability that allows you to treat a bigger stream of patients and broader stream of patients. When you think about how CyberKnife has developed over time, started out as a device focused really exclusively on intracranial tumors, brain tumors. It has become over the course of the last decade really the only true full-body radio surgery system and as we thought about, as we were seeing the product functionality of the MLC that we were receiving from the initial vendor, we saw early on that while they were able to meet our incoming technical specifications for product, they were struggling from a manufacturability standpoint. The device, while there are lots of MLCs out in the world, no one has ever mounted an MLC on a linear accelerate head at the end of a robotic arm, so that the engineering the complexity of this design, that the orientation of this product or component on a CyberKnife fundamentally makes it different than other MLCs.

The initial vendor was having trouble with manufacturability. We saw this in reduced yields and actually had identified that publicly. We really started to think twice about going forward with this when we started to do life-cycle testing, which basically resulted in and we ran this for an extended period of time, really resulted in essentially a recognition that durability and reliability of the device was not going to be what it needed to be. I mean in terms of the duration that – the time that it ran before sales, we recognized that given customers’ practices and workflow, we were going to basically create a situation where they built a treatment schedule and a workflow over time that was really going to be significantly impacted, negatively impacted, if we had the MLC not running more than, say, a month. And it was that decision quite frankly that we said we’re not going to go forward with this. It doesn’t meet our customers’ requirements for longevity. It doesn’t meet our own expectations around longevity and when you think about culturally what we have been dealing with over the last two years as a company related to product reliability issues on the Tomo side of the house that we worked so hard to fix in my mind all of the good things that we would be doing would be erased or eradicated relatively quickly with the potential market perception and customer perception that we were out in the marketplace, again with a unreliable device. And that's not where we wanted to be. The good news is that we saw that the yield challenges relatively early on and we’re already starting to think about contingency plan in terms of alternative vendor options.

Steve Beuchaw - Morgan Stanley

At this time do you still feel comfortable with the design, comfortable that the right manufacturer is the solution?

Josh Levine

Yes, we don’t believe that there is a redesign – fundamental redesign of the device required.

Steve Beuchaw - Morgan Stanley

So what kind of feedback on the M6 version that’s out there right now, one of the criticisms of the legacy CyberKnife system was that it was a little bit [niche]. I want to address that, show your tactics, how that’s going over time. But first, I want to address the user-friendliness aspect of it, the throughput aspect of it, what it does on a day-to-day basis for a center, what are you hearing so far in terms of the speed, the flexibility, user-friendliness?

Josh Levine

So in general, significant improvement across all of those dimensions. If you look at the treatment time, again in some of the higher volume situations that we have the M6 installed now, the throughput has been remarkable, when compared to what the previous device might have generated in terms of throughput capability. In the first several months of running in initial locations, again there were some patient backlog – case backlog situations in place where they had [vaults] of treatment volume that they had to go do. And they treated several hundred patients over the course of the first several months of installation and the one location that I can thinking of in Munich. And that would not have been possible with the previous generation device.

User-interface from a software standpoint, there is an upgrade on the software and the user interface is a lot more user-friendly at this point, a lot more intuitive and easier to use from a treatment planning standpoint. So the device even with fixed and Iris collimators is a pretty significant step up from the previous generation device. We’re disappointed in the timing, the delay around MLC but I need to be clear about what we have to work with, even without the MLC, we have a product that’s significantly improved over its previous iteration. We sold the CyberKnife for a decade without an MLC. So while it does have – it drives increased market opportunity for us in terms of capability going forward, we are not dead in the water without it. We have a product that still from a full body radio surgery practice is a very unique device, device that can't be replicated in terms of capabilities when you look at the other products that are on the market.

Steve Beuchaw - Morgan Stanley

So the CyberKnife system is a dedicated stereo tactic radiosurgery system. That sounds very fancy and hi-tech but it’s been a knock on the system. Some would say, well, that’s a fairly narrow niche. Is that a fair criticism? How is the size of that niche growing, if it in fact is a niche and what are the catalysts for that evolution?

Josh Levine

Great question. So I would say if you look at the history of CyberKnife over time we were a lone voice in the marketplace for probably the better part of a decade around the benefits of what’s become a fairly commonly accepted trend now towards hypo-fractionation which is increased dosing over fewer treatment cycles. And again the product in its infant stages started out focused on intracranial brain tumors but has evolved over time to include really a full-body kind of complement of case mix. We do brain, we do prostate, we do lung, we do spine. It really is a full true-body capability. It’s interesting to watch what’s happened in the market over time, because we started out as legitimately I think a narrow application, niche if you want to describe it that way and one where quite frankly our competitors were working very hard to discount the viability of that case mix nature of the requirement for it, the need for it.

It’s interesting now that our competitors are also now in the radiosurgery business and the stereotactic business. And none of them have a device quite frankly that’s as capable from a full-body radiosurgery perspective as the CyberKnife. But if you look at the different forms and different treatments within radiation therapy, SRS, stereotactic radiosurgery is actually percentage wise the fastest growing segment of the overall market. Admittedly it's probably no more than high single-digit, maybe 10% of the overall market activity today, but it's growing, and it’s growing again comparatively to some of the other categories, it’s growing the fastest. So to some degree, we feel vindicated that the market has finally woken up to this. Quite frankly it also requires that we continue to find ways to innovate and expand the capabilities of our core technology. We’ve got competitors now in their view in the radiosurgery business probably not to the same degree, I would say definitely not to the same degree that we are in it with CyberKnife but the obligation now is ours to continue to drive innovation in this area and we fully expect to be able to do that going forward.

Steve Beuchaw - Morgan Stanley

So that 10% figure that you quoted, where should that be in five years?

Josh Levine

If you look at – we get a lot of questions lately as I am sure you do about reimbursement and about kind of the broader environment around healthcare reform. I don’t think anybody can answer the question very precisely, where do the market requirements and the clinicals requirements land as a result of Obamacare or whatever form of healthcare you think – healthcare reform you think we are going to be dealing with. But there is some – I think some certainties that we are going to have to be prepared to address. One is that you are going to have to have some clinical and economic mix of health cost management justification. So we start thinking about what healthcare reform environment would prescribe or require, being able to treat patients more rapidly, getting the right kind of clinical outcomes with a rational cost structure attached to them, actually we think place into the hands of trends like and capabilities like hypo-fractionation.

The current discussion and backdrop conversation around reimbursement I think is an interesting one, because I think we probably as a company are probably better positioned portfolio wise than most with our core technologies and where the broader healthcare reform environment will land the market in terms of its clinical and economic requirements.

Steve Beuchaw - Morgan Stanley

So let’s put it all together, Josh. You have better commercial execution. You have a Tomo system that can access far more vaults than the legacy system. You have a CyberKnife system that has a nice play on a secular trend in radiotherapy. How much bigger can new Accuray be than old Accuray?

Josh Levine

I think when you start talking about fixing the commercial side of the house and the market expansion opportunities that come from the new products in our portfolio, the answer is scalability of this business has taken a very, very different picture going forward. I’d rather not speak directly to or give you a discrete number or landing point. We are a company that was quite frankly digging out of the really deep hole as of last October when I landed. And I think that while we are seeing tangible signs of progress and commercial momentum it’s way too early in my mind for us to declare victory.

In terms of investment thesis, if I were from the outside looking in this really is about commercial execution. It’s about unlocking the value that's inherent in the new technologies that we’ve just launched. It’s having the financial discipline quite frankly to be able to go forward and run this business with a financial model that allows us to cross over to profitability and sustain that profitability over time. And I think quite frankly we can do all of those things. Are we going to displace Variant as an example as the number one company in the marketplace? I don’t think that's a goal of ours quite frankly. I don’t think that’s something that should be a goal of ours. I think we can be quite frankly relatively small improvements in market share have outsized impact for us given where we are at right now. And I think that's the way I would from an investment thesis standpoint be thinking about our company and our opportunity. I don’t need to win a 100% of the battle of all battles with Variant and [Elected]. Quite frankly I know that I am not going to and I don’t lose sleep over that. But we are going to get enough of those vaults and that quite frankly we are going to be a bigger company going forward. And we are going to have the financial discipline to be able to drive what increased revenue and gross profit that we flow through the P&L, we’re going to take it to the bottom line. We are going to stop doing this quite frankly as a hobby which was pretty evident when I landed that we were making a clear route.

Steve Beuchaw - Morgan Stanley

I feel that’s a good place to wrap it up. Thanks so much, Josh.

Josh Levine

Thank you.

Steve Beuchaw - Morgan Stanley

I thank all of you for joining us.

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